Question

Hook Industries's capital structure consists solely of debt and common equity. It can issue debt at r_d = 10%, and its common stock currently pays a $2.50 dividend per share (D₀ = $2.50). The stock's price is currently $22.00, its dividend is expected to grow at a constant rate of 5% per year, its tax rate is 35%, and its WACC is 12.45%. What percentage of the company's capital structure consists of debt? Do not round intermediate calculations. Round your answer to two decimal places.

  %

Answer 1

Cost of equity = (D1 / share price) + growth rate

Cost of equity = [(2.5 * 1.05) / 22] + 0.05

Cost of equity = 0.11932 + 0.05

Cost of equity = 0.16932 or 16.932

Let weight of debt be X

weight of equity be 1 -X

WACC = Weight of debt*after tax cost of debt + weight of equity*cost if equity

0.1245 = X*0.1*(1- 0.35) + (1 - X)*0.16932

0.1245 = X0.065 + 0.16932 - X0.16932

0.04482 = 0.10432X

X = 0.4296

Weight of debt is 0.4296

Weight of equity = 1 - 0.4296 = 0.5704

Percentage of equity = 0.5704 * 100 = 57.04%